Movements in sovereign bond yields across major economies have been particularly substantial in the last few weeks, especially for longer-dated securities. Since the direction of the yield is inversely related to the price of bonds, this means that bond prices dropped, with the sharper movements occurring on instruments having a longer duration. 

Various financial media outlets highlighted that sovereign bond investors are increasingly concerned about the sustainability of government finances across major economies, as well as the implications of the re-election of Donald Trump as US president, which could lead to higher inflation. 

Within the euro area, the German 10-year bund yield surpassed the 2.60% level for the first time in eight months this week, which contrasts to the drop below the 2.10% level towards the end of November 2024. Similarly, the 20-year bund yield surged to an over one-year high of 2.85%. 

The German bonds provide the lowest yields among the euro area sovereign bonds and are considered as the benchmark risk-free rate, with other eurozone government bonds having yields at a spread above the relative German bund. It is worth noting, however, that French government bond yields increased at a faster pace, reflecting not only the global macroeconomic environment, but also the specific political issues within the country. As a result, the French 10-year yield stands close to the 3.45% level, the highest since 2011. 

Interestingly, French sovereign bonds are being priced at yields very similar levels to Malta Government Stocks (MGSs) despite France having a superior credit rating to that of Malta. A year ago, the French 10-year yielded around 60 basis points less than the corresponding MGS.

The surge in sovereign bond yields was even more pronounced in the US, with the 10-year treasury yield moving close to the 4.80% level, which is the highest since October 2023. This also means that the spread of the US 10-year bond yield relative to the German 10-year bond yield reached 220 basis points, the highest since 2019. The longer-dated US 20-year bond yield surpassed the 5% level for the first time since November 2023. 

The re-election of Donald Trump could lead to higher inflation

Some financial markets observers may be surprised to see such an upward movement in yields over the past few weeks following last year’s interest rate cuts by multiple central banks and their clear signal of a softer monetary policy stance in the months ahead. 

In this respect, it’s important to highlight that the effectiveness of the rates set by central banks is much more towards the shorter dated securities since they relate to overnight deposit rates and rates charged between banks. In fact, shorter-dated sovereign bond yields are lower when compared to the first half of 2024. 

Meanwhile, the longer-term bond yields are more influenced by market expectations. It is evident that bond investors are demanding higher yields on government bonds amid expectations of rising fiscal deficits and risks of a rebound in inflation, which in turn may cause the major central banks to be less likely to reduce interest rates further. 

Furthermore, the latest employment report published last week showed that the US labour market continues to be much more resilient than earlier projections. As such, with stable unemployment levels and an economic growth that is expected to exceed that of other major economies, the rate setters at the Federal Reserve might not consider any further interest rate cuts in the near term.

The sharp movements in yields over recent weeks were also accompanied by the strengthening of the US dollar against other major currencies. The EUR/USD exchange rate weakened to near parity, which was last seen in November 2022. This contrasts sharply to the peak of $1.12 as at the end of September 2024, which effectively means that the euro lost around 12% of its value relative to the US dollar in less than four months. 

Likewise, the British pound also weakened by about 10% relative to the US dollar during the same period. The weakening of the euro and the British pound was largely attributed to the weaker economic prospects in Europe and the UK amid geopolitical conflicts, higher vulnerability to changes in energy prices, and the threat of new US tariffs being proposed by the incoming president.

The recent developments across the financial markets are another important reminder of the need to understand and implement key financial principles when investing. For example, the surge in bond yields is a stark reminder of the time value of money and the opportunity cost of having idle money not yielding any interest or other form of cash flow. 

Likewise, the notable divergences across geographies and currencies demonstrate the need for a diversified portfolio with exposures to various sectors, economies and currencies.

Jonathan Falzon is a research analyst at Rizzo Farrugia & Co. (Stockbrokers) Ltd.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd, ‘Rizzo Farrugia’, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. Rizzo Farrugia, its directors, the author of this report, other employees or Rizzo Farrugia on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither Rizzo Farrugia, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report. 

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